Debt snowballs, avalanches, meltdowns …

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Now for today’s post

There are three basic ways to deal with debt:

1. Sweep it under the carpet and hope it goes away … pretty much the middle-class American mantra

2. Peck and poke at it … barely keeping it under some sort of control

3. Systematically demolish it … the subject of this post

The methods for ‘demolishing’ debt basically all have to do with snow (Why? No idea!):

a) Snowballs – where you deal with the little guys first in order to ‘psych up’ with a few, quick wins

b) Avalanches – where you deal with the high interest debts first, so your debt repayment strategy builds up momentum

c) Meltdowns – where you try either of these methods (or some other way) and fail mid-stream

The Debt Avalanche, nicely described (and named!) here is mathematically the best way to deal with eliminating all debt. I also covered this method in a recent post.

As I said in that post, it stands to reason that if you tackle the high interest debts first, you lower your overall interest bill – hence debt. Therefore, you pay the lot off quicker …

… but, not much quicker as Dave Ramsey is quick to point out:

He says that the debt snowball isn’t terribly slower at paying off debt, but has a psychological advantage of allowing some quick ‘wins’ … by ordering your debts from smallest to largest and paying off the smaller ones first, you get to see the results that will hopefully sustain you as you start to tackle the larger debts (also, you are applying larger and larger amounts to each debt, as you have fewer and fewer ‘minimum payments’ to maintain as you go along … but, this is true with both methods).

Then you have the ‘Debt Meltdown’ aptly described by Diane, one of the Final 15 on my 7 Millionaires … In Training! ‘grand experiment’:

I’m in such a financial mess that I am working on 101 and not sure I’m going to survive that at times.  But I should.  I know I make a lot more money than many folks.  I shouldn’t be in this situation.  I could probably go back and show how it crept up because I was down to about 2k in debt, at 1.9% interest rate (sans the student loan), before I bought my house 2-1/2 years ago.  I’ve got 30k in debt now roughly and some months lately am not sure how I am going to meet all of the must-pay bills.

This is typically what happens when you start on any debt repayment schedule and something ‘comes up’ …

Diane should have stayed the course until all debts were paid off then bought her house, ensuring that her total mortgage wasn’t any more than the total monthly debt repayment schedule … if less, she should have applied the balance to her investment strategy (if she didn’t yet have an investment strategy, then she should have started that before considering the house).

All Diane can do now, is start a Controlled Meltdown …

… anyway, of all these methods, I actually like the Controlled Meltdown best  – and, for that to work you actually need to begin with the Debt Avalanche:

1. Order all of your debts from lowest interest rate to highest (regardless of size … if you have two debts at the same interest rate, tackle the smaller one first, just to please Mr Ramsey)

2. Decide how much each month you are going to apply to debt repayment (min. 10% – 15% of your net salary … after contributing to 401k … sorry no Starbucks, movies, or sushi for you!).

3. Pay the minimum on all of the debts except the one that you are tackling (always the highest interest rate loan that you have left). Put all of the rest of that month’s debt repayment into this ‘high interest debt’.

4. Repeat until …

[AJC: and, this is where a Millionaire … In Training! differs from the ordinary folk]

5. The interest rate on the remaining loans is lower than the return that you can get by investing your money elsewhere (buy some real-estate, leverage into some stocks, start a little business) … just remember not to accumulate any more debt and keep repaying the minimum on the ones that you do have.

6. Also, don’t forget to tie the investment time period to the loan: let’s say that you have a student loan at 2.9% that must be repaid in 2 years … make sure that you can sell (or refinance) your investment to pay it back: the student loan is acting as a proxy for your investment loan, so don’t get caught out.

This is the fastest method because you don’t need to pay off all of your debt right now!

The Controlled Meltdown (patents pending) recognizes that being 100% debt-free is not a useful financial goal; being 100% financially-free is … and, to achieve real financial freedom, you are going to need some well-directed debt to help you accelerate you Net Worth to the point that it indefinitely sustains you.

Your existing ultra-low interest rate loans are a great place to acquire that debt …

… because you already have them and just need to redirect that debt towards good rather than evil 😉

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9 thoughts on “Debt snowballs, avalanches, meltdowns …

  1. AJ – I am glad you wrote about this, but I think you just contradicted yourself. Since my remaining debt was at 1.9%, I evaluated that putting money into a house as an investment to keep me from sinking it in the rental pit (aside from the perks of a garage and yard and room for a mobile security system (“single woman needs dog”), was a better use of my income.

    But I am sure that there was where I disconnected from considering all the variables (going to the emotional needs) and probably bought sooner than I should have.

    Better financial advisors in my life at that time might have helped me see clearly where to go.

    I’ll leave all the personal factors out of this post for now.

    Back to the debt repayment. I recently (this summer while traveling) made a late payment on a bill and the credit card company (CHASE) raised my rate from 3.9% to 14.99 percent. I’ve discussed this with them and they are considering whether to return it to the rate of 3.9%. In a similar situation (within the past calendar year), with the same company (CHASE) on another card, they returned the rate immediately with the phone call and stated something about allowing this to occur one time. I guess I will find out if it is one time per card, or per company. CHASE has somehow managed to prevent my online banking company from accessing my bill from them monthly (they were on the “pay the minimum monthly” cycle, which my bank will do automatically for me. SO, I returned to receiving paper billing so I could ensure they got paid (one didn’t at some point, this might have been the one that happened last fall). This summer, traveling, I set up automatic payments. We will see what CHASE’s decision will be, but I will cancel all of my accounts with them based on their being too much trouble in my life to deal with. The company with the 1.9% card is CAPITAL ONE and they have always dealt straight and fair with me, never had a problem with them on billing being received on time, even through the online banking services. However, my debt on CHASE is much higher than on CAPTTAL ONE, so I am going to pay off the CAPITAL ONE card (Dave Ramsey method) and hope they send me another offer at a low rate to transfer balances. I will then transfer the CHASE card over to CAPITAL ONE, then reevaluate the interest rates on all debt/investments and start with the highest rate first, which is how I had been tackling the debt. I also cancelled contributing to the 401k this paycheck, indefinitely, because the investments now are losing (which means I get a better return on paying off the debt), plus this experiment has taught me that there “ain’t no way” I can return on my 401k ever. I just am restarting life after divorce too late. Something else much change to allow me to meet my personal goals.

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